Significant accounting issues

The Committee considered the following significant issues in relation to the 2014 financial statements:

The valuation interest rate is the discount rate at which annuity payments are discounted to the present date. The financial results are sensitive to changes in the valuation interest rate.

The longevity assumptions estimate how long policyholders receiving annuity payments will live. The financial results are sensitive to the choice of, and changes in, the longevity assumptions.

The Committee closely monitored the matters that change the valuation interest rates and in particular:

  • Investment data used to calculate the yield on the assets backing the insurance liabilities;
  • Credit default assumptions; and
  • The methodology used to model the asset cash flows to calculate the internal rate of return
The Committee is concerned to ensure that the investment data used for modelling insurance liabilities is correct, that credit default assumptions are appropriate and that the assumptions made in setting the credit default allowance appropriately represent the group’s exposures and current market conditions.

The Committee studied the results of the default provision methodology by asset type and concluded that the total provision was appropriate.

The Committee also reviewed how the longevity assumptions are calculated, including the use of internal experience analyses and judgement, and the impact of future improvements to mortality (for example, due to expected medical advances) estimates using external industry studies and guidance in the UK.

The group’s investment portfolio includes commercial loans, CDOs and OTC derivatives. These are significant in size and changes in estimates could result in material changes in their valuation.

The Committee is concerned to ensure that the valuation process for these investments is robust and that appropriate controls are in place to mitigate the risk that valuations are performed incorrectly.

This included consideration being given to the OTC derivatives front office controls approval and authorisation processes.

The group’s investment portfolio also includes more complex instruments, such as investment property, where there is no direct price from an active market and the valuation by its nature includes judgement. Further, property valuations are generally performed less frequently than for other classes of asset and some of the group’s property investment transactions are unique in terms of structure and therefore can require complex accounting treatment.

The Committee has considered the processes of the group in the valuation of complex investments. In particular, the Committee has reviewed the work of internal and external audit on the control environment surrounding the valuation of investment property and monitored the delivery of process improvements.

Internal control framework

The Committee considers control environment issues, root causes and management’s responses and follow up activities. It is assisted by the work of both internal audit and the external auditor.

In conjunction with the Group Risk Committee, the Committee assists the Board in ensuring the group operates within a framework of prudent and effective controls that allows risk to be identified, assessed and managed. Implementation and maintenance of the internal control systems are the responsibility of the executive directors and senior management. Where failings or weaknesses have been identified, actions have been taken to remedy these. The group’s control policies and procedures, which are in accordance with Turnbull Guidance, have been in place during 2014 and up to the date this report was approved. The group’s system of internal control is designed to manage rather than eliminate risk and can only provide reasonable and not absolute assurance against material loss.

During 2014, the Committee was assisted in its activities by regular reports from the group’s internal audit function on their audits and assessment of the control environment. The Committee reviews the effectiveness of the group’s internal audit function, including internal audit resources, plans and performance as well as how the function interacts with management. In particular, the Committee considers the alignment of the internal audit plan with the company’s key risks.

A significant focus during 2014 has been the implementation of changes in response to the high standards set by the Chartered Institute of Internal Auditors (CIIA) Guidance for Internal Audit in the Financial Services sector (the CIIA Code) issued in July 2013.

The Committee oversaw the recruitment of a new chief internal auditor, and reviewed the target operating model for the company’s internal audit function and recommendations for developing the function towards the CIIA Code’s standards to support ongoing delivery of effective internal audit assurance.

The Committee also received and considered reports from the external auditors on their assessment of the control environment as well as reports from senior management on how they are responding to internal control recommendations made by internal audit and the external auditors.

The internal control and risk management systems cover the company’s financial reporting process and the group’s process for preparation of consolidated financial statements. For 2014, the Board was able to conclude, with reasonable assurance, that appropriate internal control and risk management systems were maintained throughout the year.

External auditors

Each year, the Committee reviews the external auditor’s audit plan to ensure it aligns with the Committee’s view of the significant risk areas of financial misstatement. The Committee receives regular reports from the external auditor on audit findings and significant accounting issues.

The Committee judges the external auditor on the quality of their audit findings, management’s response and stakeholder feedback. The Committee assesses the effectiveness of the external auditors against the following criteria:

  • Provision of timely and accurate industry specific and technical knowledge
  • Maintaining a professional and open dialogue with the Committee Chairman and members at all times
  • Delivery of an efficient audit and the ability to meet objectives within the agreed time frames
  • Provision of sufficient resource and high quality and consistent advice at all times

The Chairman meets regularly with the external auditor throughout the course of the year.

The Committee reviews and approves the terms of engagement of the external auditor and monitors the independence of the external auditor including overseeing, and in certain circumstances approving, the engagement of the external auditor for non-audit work.

The Committee is cognisant of the requirements governing the appointment of external auditors, notably the requirements of the Competition Commission and European legislation in relation to the mandatory re-tendering of audit services every 10 years, together with the mandatory firm rotation proposals from the European Commission.

PricewaterhouseCoopers LLP has been our external auditors for a number of years. The audit was last tendered in full in 2006 with a partial re-tender process in 2009. The current intention of the Committee is to carry out a review at an appropriate time between now and 2017 in line with the new audit tender requirements.

There are no contractual obligations which restrict the Committee’s choice of external auditor.

In 2014, the group spent £1.6 million on non-audit services provided by PricewaterhouseCoopers LLP. Further details can be found in Note 37 to the consolidated financial statements. This represents 28.6% of the total audit fee for 2014.

Analysis of current and prior-year spend on audit, other assurance and non-assurance services:

 

2014

2013

2012

Audit and related

5.6

5.6

4.6

Other assurance

0.9

0.1

1.8

Non-assurance

0.7

1.3

1.1

Total

7.2

7.0

7.5

The group’s policy requires that all services with an anticipated cost in excess of a specified amount are subject to a full competitive tender involving at least two other alternate parties in addition to the external auditor. If the external auditor is selected following the tender process, the Committee is responsible for approving the external auditor’s fees on the engagement. For services with an anticipated cost below the specified amount, the group chief financial officer has authority to approve the engagement. The external auditor and management report regularly to the Committee on the nature and fees relating to non-audit services provided under this authority.

In order to maintain the objectivity of the external audit process, the Committee supports the rotation programme for audit engagement partners who are required to rotate every five years. The current audit partner commenced his engagement in 2013.

The Committee continues to consider PricewaterhouseCoopers LLP to be the appropriate audit firm for the company taking into consideration their audit effectiveness and the audit needs of the group.